Best’s Commentary: LIBOR Transition to Secured Overnight Financing Rate Rapidly Approaching

As the process for replacing the London Interbank Offered Rate (LIBOR) nears its conclusion, existing contracts that do not provide for the use of a replacement benchmark rate may pose operational risks to some companies during the transition, according to a new AM Best commentary.

The Best’s Commentary, titled, “LIBOR Transition to SOFR Rapidly Approaching,” notes that a large volume of USD-denominated LIBOR contracts mature after June 30, 2023, and lack adequate fallback provisions.

However, a federal law that took effect at the end of 2022 allows the Federal Reserve to choose the benchmark rate for LIBOR contracts lacking a fallback provision or whose fallback provisions do not adequately determine a benchmark replacement, providing protection. If a new benchmark rate is not selected by the June 30 deadline, the rate selected by the Federal Reserve will apply.

“LIBOR exposures appear on both the asset and liability sides of balance sheets,” said Helen Andersen, industry analyst, AM Best. “LIBOR’s benchmark rates are widely incorporated into contracts and financial instruments such as corporate bonds, structured bonds, mortgages, loans, and derivatives.”

The Fed’s Alternative Reference Rates Committee has encouraged market participants to transition ahead of this summer’s deadline from LIBOR to the Secured Overnight Financing Rate (SOFR), which is a measure of the cost of overnight borrowing collateralized by U.S. Treasuries.

Due to concerns about manipulation, the U.K. Financial Conduct Authority announced nearly five years ago that it no longer planned to persuade or compel banks to make LIBOR submissions beyond the end of 2021. The USD-denominated one-week and two-month LIBOR tenors were no longer published after Dec. 31, 2021. The remaining USD-denominated LIBOR tenors will be phased out June 30, 2023.

In late July 2021, U.S. regulators began requiring that interest rate swap desks execute derivative transactions tied to SOFR instead of LIBOR, adding much-needed liquidity with SOFR derivatives and promoting SOFR lending. SOFR has since become the dominant benchmark for derivatives.

Insurers’ debt structures may also be impacted, especially those that have either floating rate obligations currently tied to LIBOR or fixed rates that will become floating rates based on LIBOR— including floating rate surplus notes that are part of many insurers’ capital structures. As the transition deadline approaches, insurers should be aware of their exposure and assess their operational capabilities in anticipation of the number of contracts that may be changing as a result.

To access the full copy of this report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=331425 .

AM Best is a global credit rating agency, news publisher and data analytics provider specialising in the insurance industry. Headquartered in the United States, the company does business in over 100 countries with regional offices in London, Amsterdam, Dubai, Hong Kong, Singapore and Mexico City. For more information, visit www.ambest.com.

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